UK commercial property market could see short term weakening due to Brexit

Image The UK commercial property market is likely to see a weakening in demand due to the decision of the British people to leave the European Union.

Foreign investors in particular are likely to cool while the terms for the country to leave are thrashed out as uncertainty about direction and timing affect decision making, according to experts.

Even if it is effectively ‘business as usual’ for the UK in terms of trade and legislation until 2018 when the actual exit is likely to take place, such a major change will inevitably create uncertainty in the economy and real estate markets, according to Chris Ireland, chief executive officer of JLL UK.

He explained that in the event of a well-managed exit these impacts will be largely confined to the UK. ‘In the short term we may see a weakening in occupier demand. The impact on rents may be limited by tight supply, but activity will be adversely hit while initial uncertainty about direction and timing continues,’ said Ireland.

‘Investor sentiment may also remain subdued in the short to medium term. For property markets, the initial correction may be most severe but should be followed by an upturn as opportunities re-emerge in UK core markets and benefits of weak sterling are recognised. Sentiment and relative pricing will be key,’ he pointed out.

‘Much will depend on the speed of negotiation, the wider political picture and whether a clear direction of travel and timetable for an EU exit is established early on,’ he added.

According to an analysis by JLL occupier demand will weaken in line with economic growth and declining business sentiment. The impact on rents may be limited by tight supply, but activity will be adversely hit.

It also suggests that investor sentiment will deteriorate further, subduing capital flows in the short to medium term and there is likely to be a negative capital value adjustment over the next two years, estimated at a fall of up to 10% with yields moving around 50bp.

It points out that London sectors remain most vulnerable to correction given current keen pricing and their multinational occupier base but much will depend on the speed of negotiation, the wider political picture and whether a clear and favourable direction is established early on.

According to Mark Clacy-Jones of international real estate firm Knight Frank the decision will cause volatility across all investment markets, and real estate will be no exception and he predicts that uncertainty over future economic conditions in the UK will cause some deals on hold to be shelved, and occupiers will reconsider the amount of space they need outside of the single market.

‘A fall in the value of sterling, combined with falling property values will be a buy sign for opportunistic overseas investors once the initial correction has occurred. This will cause a widening yield gap as real estate yields rise and bond rates fall from further Bank of England monetary loosening and will make property a favoured asset class in an unpopular investment destination,’ he said.

In particular, the vote to leave the EU creates both threats and opportunities for the central London office market, according to his colleague at Knight Frank Patrick Scanlon. ‘Economic uncertainty is rarely a positive for any market, and in the short term we should expect some occupiers to delay committing to new office moves as they take stock of what the new landscape means for their businesses,’ he explained.

‘London represents the largest market for euro-denominated trading, and major banks with euro trading desks in London may find that they need to relocate some of these functions to office markets within the EU. While this does not necessarily mean a wholesale relocation, we should expect some vacant space from banks to come to the market once this restructuring has taken place,’ he said.

‘However, it should be noted that many businesses with a large London presence are focused on markets outside the EU, and the UK’s exit from the Union will have a limited impact on them,’ he pointed out, adding that global operators such as Deutsche Bank, Thomson Reuters, Ashurst, Google and Facebook have made significant long term commitments to London.

However, he believes that there is likely to be some release of office space as businesses tighten their belts to weather the period during which trade treaties are being negotiated. ‘Currently availability levels are particularly low and the development pipeline remains fairly limited. The market has capacity to absorb a rise in supply before there is a possibility of a fall in prime headline rents,’ said Scanlon.

‘The impact on the investment market is likely to be less obvious. While the economic uncertainty during our exit negotiations will undoubtedly deter some domestic investors, the relative discount available to purchasers in foreign currencies will attract significant interest. In the medium-term however, Central London commercial property will continue to offer a higher yield than most other asset classes, and may even benefit from the instability in the equity markets,’ he added.

Craig Hughes, UK real estate leader at PwC, pointed out that real estate is a capital intensive business and real estate investors do not react well to uncertainty and in recent months that has had an impact on the real estate market.

He believes that there are immediate consequences resulting from exiting the EU, but also longer term uncertainties arising from political uncertainty, the timing of the submission of Article 50 and the reaction of European officials and citizens.

The decision may create short term volatility but over the long term the UK is set to remain attractive to real estate investors, according to Manish Chande, a senior partner at Clearbell. ‘We saw during the referendum campaign that this created buying opportunities at significant discounts for savvy investors. As the uncertainty gradually lifts and investors are reminded of the strong fundamental factors that make UK real estate attractive, we’d expect real estate activity to pick up,’ he said.

It is difficult to forecast the effects that Brexit will have on the commercial property markets, according to Philip Woolner, director of Cheffins Commercial. ‘Ultimately, the UK is such an attractive market for overseas investment that any knock-on effect is likely to be short lived,’ he said.

‘There is a possibility of a period of stalling across investment sectors, with occupiers choosing to stay put, however, the fundamental prospects of business will still be strong,’ he added.

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